[Practical Finance] Era of Global Arms Race... A Golden Opportunity for K-Bangsan

Deepening and Acceleration of the New Cold War System... Positive Impact on K-Defense with High Proportion of Ground Weapon Exports
Performance Improvement of Hanwha Aerospace, LIG Nex1, Hanwha Systems, Korea Aerospace Industries, etc.

Editor's NoteThere is a sector that value investors have recently taken great interest in: the 'K Industry.' This is not due to patriotic sentiment or 'gukppong' (nationalistic pride). Rather, it is because K Industries such as K Defense, K-Pop, and K Ramen have proven their competitiveness in the global market, leading to analyses that they have strong potential for sustainable growth from an investment perspective. The 'K Industry,' which has survived through relentless research and development and fierce competition in the Korean market, boasts exceptional competitiveness in the global market. Among them, we analyzed the growth potential of the outstanding 'K Defense' and 'K-Pop.'

As the Russia-Ukraine war prolongs, countries across Europe, North America, Asia, and the Middle East are increasing their defense budgets. Last year, Poland imported a large number of domestically produced weapons such as the K2 tank, K9 self-propelled howitzer, and FA-50 light attack aircraft. Exports of key strategic items developed with domestic technology have shown strong performance overseas. South Korea's average weapon export volume over the past five years has grown by 74%, achieving the highest growth rate among the global top 10 defense exporters. In particular, the large-scale defense contract signed with Poland in the second half of last year is expected not to be a one-off deal. As order backlogs accumulate, it is anticipated that new export countries will be added. Domestic projects are also accelerating.

Russia recently expressed hostility toward Western countries in its revised foreign policy documents. There are signs of reverting the names of former Soviet states to those used during the Soviet era. The confrontation system may extend from 'China-Russia vs. the West' to internal divisions within Europe. If the new Cold War intensifies and accelerates, defense spending in Europe is expected to increase. Although demand for ammunition and weapons has surged, production facilities within Europe are insufficient. Cooperation within Europe also appears challenging. As Europe emerges as the largest market for the defense industry, domestic defense companies have an opportunity to increase orders. Given that recent demand is concentrated on ground weapons, this is positive for K Defense companies with a large share of ground weapon exports.

Hanwha Aerospace, which dreams of becoming the Korean version of 'Lockheed Martin' by integrating defense affiliates within its group, is a K Defense company particularly noted by the investment community. From the fourth quarter of last year, it began delivering K9 self-propelled howitzers to Poland. Rocket Chunmoo exports are expected to be added next year. A second contract with Poland is scheduled from the end of the second quarter to the third quarter this year, so the order backlog is expected to steadily increase. Although the Australian Army's next-generation armored vehicle project 'Land 400 Phase 3' was reduced from 450 to 129 units, it is still expected to positively impact performance. Additionally, after signing a memorandum of understanding (MOU) with Romania in February, the defense budget has been submitted, and new orders are expected as early as this year. The company's main ground defense export item is the K9 self-propelled howitzer. It is exported to a total of eight countries and holds the global market share number one. The export ratio within the order backlog approaches 70%. Significant performance growth is expected in 2024 when sales will be fully reflected. Jiho Lee, a researcher at Meritz Securities, said, "Based on favorable policies and macro environment, both order backlog and performance are expected to trend upward."

LIG Nex1, equipped with a Korean-style missile defense system, is another defense company gaining attention due to the prolonged Russia-Ukraine war. The successful interception and defense of hypersonic strategic weapons used by Russia by Ukraine has been publicly revealed, increasing demand for interceptor and guided weapons. In the Middle East, interest in guided weapons is high to defend against drone attacks on oil storage facilities and ballistic missile threats. South Korea is a country directly exposed to missile threats from North Korea.

With the recent increase in North Korea's missile provocations, efforts to build a Korean-style missile defense system are accelerating. At the Defense Acquisition Program Administration Committee held in April, the basic strategy for the Long-Range Surface-to-Air Missile (L-SAM) II project was approved. The development of Cheongung-III, an upgraded version of the Medium-Range Surface-to-Air Guided Missile (M-SAM), was also decided. LIG Nex1's role is expected to become more prominent. Seungdoo Na, a researcher at SK Securities, said, "Although there is a preference for investment centered on defense materials with publicly increasing exports, attention should also be paid to whether exports of items that cannot be widely exposed externally due to the nature of strategic weapons increase." He added, "Quarterly profit margins may vary depending on the execution and delivery timing of development projects, but globally, guided weapons are just entering their golden age, so the trend in export ratios should be closely monitored."

Hanwha Systems is also a major K Defense company responsible for tactical communication systems, electronic warfare equipment, combat systems, and multifunction radars. It handles key components and technologies that serve as the brain of South Korea's combat systems such as fighter jets and tanks. The Korean fighter jet KF-21, which received provisional combat suitability certification and will enter mass production in 2024, will be equipped with an AESA radar developed by Hanwha Systems. The AESA radar scans electromagnetic waves to simultaneously detect and track multiple targets. It is directly linked to the survival of the fighter jet. The K2 tank, recently exported to Poland, also requires various devices essential for survival. The tank's active protection system detects incoming attacks and responds in advance to increase the tank's survivability. As exports of South Korea's combat systems increase, Hanwha Systems' performance is expected to improve accordingly.

Korea Aerospace Industries (KAI) holds the largest order backlog among domestic defense companies. As of the end of the first quarter, it stood at 25.0537 trillion KRW, equivalent to 8 to 9 years of last year's sales. It also secured the most new orders in the first quarter. KAI signed new contracts worth 1.3775 trillion KRW in the first quarter. The expansion of the order backlog was driven by a 1.2 trillion KRW FA-50 export contract with Malaysia. From the third quarter of this year, the order volume is expected to be fully reflected in performance. Sales of 800 billion KRW are expected in the second half of this year from FA-50 deliveries. During the same period, two advanced trainers will be delivered to Thailand. Starting next year, KAI is preparing to supply the remaining 36 of the 48 FA-50s contracted with Poland and 18 FA-50s to Malaysia. It is also preparing to participate in the U.S. Air Force and Navy training and tactical introduction aircraft project worth 20 to 25 trillion KRW and the KF-21 mass production contract worth 4 trillion KRW.

With the expansion of K2 tank exports, Hyundai Rotem is also attracting attention from domestic and foreign investors. Hyundai Rotem's operating profit in the first quarter (31.9 billion KRW) surged 35.5% year-on-year. This performance was supported by record-breaking results in the defense sector. The order backlog (as of the end of the first quarter) was 14.3139 trillion KRW, a 43% increase compared to the same period last year. In the defense sector alone, it surged 246% to 5.5017 trillion KRW. The Polish military plans to introduce up to 1,000 K2 tanks. Hyundai Rotem signed the first export implementation contract for K2 tanks with Poland in August last year, agreeing to export 180 urgently needed units by 2025. On March 31 this year, it signed a consortium implementation agreement with Poland's state-owned defense group PGZ and its affiliates for the production and supply of the locally upgraded K2PL model and is negotiating the main contract. Jaegwang Lee, a researcher at NH Investment & Securities, said, "Aerospace and defense industries require advanced technology and large-scale capital and are directly linked to national defense capabilities, so they tend to grow significantly during periods of intense competition between countries." He added, "With the full onset of the new Cold War era, structural growth in aerospace and defense industries is possible."

This content was produced with the assistance of AI translation services.